RMB Wildcard?

Sep 8, 2022

With the Chinese renminbi (RMB) approaching the seemingly key threshold of “7” relative to the US dollar, rumor-driven foreign exchange markets are on edge. Those fears are overblown for three key reasons:

First, RMB management is the least of China’s current multiplicity of concerns. As I stressed recently, the headwinds to Chinese economic growth are now blowing fiercely. With zero-covid lockdowns intensifying once again in the face of China’s record heatwave, slowing global growth, and ongoing regulatory pressures on its once dynamic tech sector, a weaker currency will help cushion China’s growth pressures.

Second, RMB weakness is hardly a surprise in light of the divergence in monetary policies between the US and China.  The Fed still has far to go in its current monetary tightening campaign, whereas the Peoples Bank of China (PBOC) has been moving the other way by easing monetary policy. Unlike the US with a serious inflation problem, Chinese inflation risks are minimal — underscoring the risk for further policy divergence driving additional RMB depreciation in the months ahead.  With Chinese export growth now slowing in a weakening global climate, PBOC currency managers are likely to view RMB depreciation as an added instrument in its countercyclical policy arsenal.

Third, from a currency management perspective, central banks typically worry less about cross-rate thresholds (like “7” vs. the US dollar) and more about the pace of major shifts.  Disorderly adjustments in foreign exchange markets can jeopardize financial stability.  Yes, over the past six months, the RMB is down 9% versus the US dollar.  But that is comparable to the 10% drop of late 2018; moreover, with BIS metrics showing the broad trade-weighted RMB still up some 19% in real terms over the past ten years (and 42% over the past 20 years), the upside trend of a strong RMB remains intact.

The biggest problem stemming from the recent weakening of the RMB is the risk of collateral contagion in other emerging market currencies.  While this is not the highest priority for growth-fixated Chinese policymakers, it is certainly worrisome for highly-indebted emerging economies, as well as for global markets and the world economy.

You can follow me on Twitter @SRoach_econ

Sign up for Stephen’s Dispatches: